Will Silver Remain the Belle of the Ball?

All eyes are on the silver price, but that may change when it reveals its true colors.

While gold teeters near $1,800 as it digests a flood of economic data, silver has been riding high. Moreover, while the white metal has left gold in the dust in recent weeks, the implications are bearish, not bullish.

Please see below:

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To explain, the gray line above tracks the iShares Silver Trust (SLV)/SPDR Gold Shares (GLD) ratio. If you analyze the right side of the chart, you can see that the metric is gunning for its 2022 highs. However, while it may seem like a positive development, we’ve noted that silver is often the canary in the coal mine for bearish reversals. As such, gold, silver and mining stocks should resume their downtrends sooner rather than later.

To that point, while the crowd remains hopeful for a dovish pivot, we warned on Dec. 8 that a realization is unlikely without a collapse of the U.S. economy. Therefore, the silver price should suffer from rising interest rates and quantitative tightening (QT) in the months ahead. We wrote:

While the consensus expects a recession and assumes a dovish pivot will arrive soon, the price action contrasts the narrative. In reality, when dovish pivots occur, the economic outlook is so dire that asset liquidations are already underway.

In contrast, they don’t occur with a near-record-low unemployment rate, near-record-high wage inflation and ~40-year high output inflation. Consequently, while the post-GFC pivots made it seem like the Fed could solve any problem, it’s much different when inflation is ~4x the annual target.

As evidence, the Fed continues to remove liquidity from the system.

Please see below:

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To explain, the red line above tracks the Fed’s balance sheet. If you analyze the right side of the chart, you can see that it hit a new 2022 low on Dec. 7 (updated on Dec. 8). Also, nearly all of the bond-buying since November 2021 has been unwound and more of the same should occur over the medium term.

In addition, while interest rates have declined amid the recession hoopla, rate hike expectations signal the Fed is nowhere near a dovish pivot.

Please see below:

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To explain, the orange line above tracks the U.S. 10-Year Treasury yield (10Y), while the blue line above tracks the yield on the March 2023 Eurodollar (ED) futures contract. For context, the latter is used as a proxy for the FFR.

If you analyze the right side of the chart, you can see that the orange line’s pullback has not been matched by the blue line. As a result, while the 10Y has dipped amid all the recession headlines, the ED contract has barely budged. Thus, all signs point to a 5%+ FFR and a further liquidity drain, not rate cuts and a resumption of QE.  

Also noteworthy, Indeed released its wage growth report on Dec. 8. An excerpt read:

“The Wage Tracker shows U.S. posted wages grew in November at a robust 6.5% YoY pace, up from 3.1% in November 2019. Nevertheless, YoY posted wage growth has declined substantially in recent months, falling from a peak of 9% in March 2022, a signal employers now face less-steep competition for new hires.”

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So, while wage inflation has slowed from its 2022 peak, this was expected after the Fed hiked interest rates 15 times (25 basis point increments) in 2022. Moreover, the tally should reach 17 if a 50 basis point rate hike materializes on Dec. 14. 

The important point is that the Fed needs to reduce wage inflation to a rate that supports 2% output inflation; and 6.5% is far from that level. Furthermore, it’s our view that the decline in wage growth is relatively modest, given the sharp rise in the FFR. Remember, the Fed predicted in September 2021 that the FFR would hit 0.3% in 2022.  

As such, 6.5% wage growth in the face of massive rate hikes highlights the resiliency of demand and the challenges that should confront the Fed as it attempts to rein in inflation. Consequently, Indeed noted that it could take a while for wages to revert to their pre-pandemic trend, and 6.5% wage growth means average Americans can support 6.5% output inflation. 

Please see below:

TextDescription automatically generated with low confidenceSource: Indeed

Overall, the silver price has benefited from a false belief that an imminent recession will spark a dovish pivot and re-ignite the liquidity firehouse. But, the reality is that Americans are still flush with cash, and investors are in la-la land if they think inflation will subside when wages are running at 6% to 15% depending on the source.

Therefore, while sentiment can keep the silver price uplifted in the short term, the medium-term technicals and fundamentals signal a substantially different outcome.

Alex Demolitor,
Precious Metals Strategist